Seeking Alpha
Long/short equity
Profile| Send Message|
( followers)  

Plenty of public outcry, pension divestment, and political jockeying have been surrounding the gun industry lately. As a Libertarian, I stand somewhere in the middle regarding the gun debate and the right to bear arms. So thinking about the recent events through the lens of a pragmatic investor, I took a closer look at the stocks of gun manufacturers, specifically Smith & Wesson (NASDAQ:SWHC).

First of all, I think their new CEO is a badass. I've never met the guy, but through Google (NASDAQ:GOOG), I've learned he's made his way through the corporate ranks as a salesman serving as the President of Presto (an appliance company that makes pressure cookers and trash bags) to the selling firearms! The first line of his LinkedIn (NYSE:LNKD) states: "High-energy and financially astute company president with track record in transforming businesses - building both top-line and EBITDA growth."

Granted it's only social media but I get the impression he cares about his shareholders. And SHWC's stock price since he took over as boss (roughly 2 years ago) proves it. He's a salesman who understands his target demographic. Not only does SWHC donate substantial money to charities for veterans returning from war, he pulls Smith and Wesson as a sponsor from a gun show that didn't want to display assault rifles - a move that is sure to fire up his customer base!

From fundamental perspective, SWHC is cheap. Especially considering, when giving my stable growth assumptions, I refuse to show any love to any CEO ever - even if I have a slight affinity towards his overwhelming manliness for running a gun company.

Most importantly, I believe the current hysteria of gun purchases is unsustainable. The long-term trend of gun purchases should follow the growth rate of the economy. Pending an apocalypse, there should be no difference between the next 20 years of gun demand and the previous 20. Below I've included my projections that take into account today's buying frenzy that I expect will persist for the next 2 years of Obama's 2nd term and will immediately return to long term 4% growth rate.

The next two years of high growth earning were taken directly from average analyst projections from the street. Below is my assumptions assuming the lower analyst estimate of earnings for 1.04 (FY13) and .94 (FY14):

1

2

Earnings

$1.04

$0.94

- (CapEx-Depreciation)*(1-DR)

($0.02)

($0.03)

-Chg. Working Capital*(1-DR)

$0.09

$0.10

Free Cashflow to Equity

$0.97

$0.87

Present Value

$0.90

$0.74

Growth Rate in Stable Phase =

4.00%

FCFE in Stable Phase =

$1.38

Cost of Equity in Stable Phase =

10.00%

Price at the end of growth phase

$23.05

Present Value of FCFE in high growth phase

$1.64

Present Value of Terminal Price

$19.67

Value of the stock

$21.31

Estimating the value of growth

Value of assets in place =

$12.34

Value of stable growth =

$9.05

Value of extraordinary growth =

($0.08)

Value of the stock

$21.31

Because Gordon growth models require many assumptions about future growth, especially given the current regulatory wildcards, I believe a margin of safety of 50% is sufficient. This puts my current value of SWHC at $10.65 (a 21% premium to the stock price as of the time of this writing).

Conclusion

As a contrarian, nothing screams more obviously profitable than a bunch of liberals telling a bunch of conservatives what to do and how to think. This is one of those rare opportunities to profit off the irrationalities on BOTH sides of the debate.

Source: Smith & Wesson Is A Buy